Asset allocation is a lot like driving: You decide where you want to go, and then you pick the fastest route.

The destination is your financial goal, whether it’s salting away money for grad school or for retirement. The fastest route can vary, of course, but what you try to do is put your money into the riskiest asset groups you can stand (because, long-term, those are the ones making the most money). To cut down some of that risk, you diversify, putting your money in a variety of kinds of asset groups, so they won’t all plunge downward at once.

As a component of financial management, asset allocation is often skipped over, because it’s not nearly as fun as, say, picking individual stocks. But it’s much more important to the success of your investments.

A famous 1991 study found that 82% of a portfolio’s returns stems from the decision of what asset groups to buy — the dividing of savings among cash, stocks and bonds, even real estate.

Asset allocation is an individual choice, varying according to age and income. Which of these three hypothetical profiles sounds most like you? (Each case presents the basics of asset allocation.)
But wait, you say. What if I don’t fit any of these snapshots?

Single 30-year-old writer
I have about $15,000 worth of equity in real estate. I have $15,000 in stock in a former employer’s retirement plan, and about $1,000 worth of stock in a new retirement plan. I have a pretty good TV.

Here’s my current allocation of that $24,000:

0% cash
0% bonds
42% real estate
58% stocks

Where do I want to go?

I have no immediate need for cash — no big plans to go to law school — so it’s OK by me that all my financial assets are in stocks; I can always sell them.

Still, my savings were drained away by the down payment on my apartment, and my financial snapshot calls for a rebuilding of cash on hand. My next goal, while continuing to put money into my retirement plan, is to put away three months’ salary in my checking account.

Single 30-year-old writer
Suggestions: Once I decide on those aims, I can figure out ways to get there (for example, an automatic savings plan that takes away 10% of my salary before I see it; moonlighting and putting the cash directly in a brokerage account).

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